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Thursday, February 18, 2016

18/2/16: Fiscal Space By Numbers: Village Magazine January 2016

This is an unedited version of my column for Village Magazine, December 2015.

Two recent events highlight the true nature
of the ongoing Irish economic recovery.

Firstly, ahead of the infamous
Ireland-Argentina Rugby World Cup match, the press office of the main Irish
governing party, Fine Gael, produced a rather brash inforgraphic. Charting
projected growth rates in real GDP for 2015 across all Rugby World Cup
countries, the graph put Ireland at the top of the league with 6.2 percent
forecast growth. “FACT: If the Rugby World Cup was based on economic growth,
Ireland would win hands down,” shouted the headline.

Having put forward a valiant performance,
Irish team went on to lose the game to Argentina, ending its tour of the competition.

Secondly, within weeks of publication,
Budget 2016 – billed by the Government as a programme for the ‘New Ireland’ –
has been discounted by a range of analysts, including those with close
proximity to the State as representing the return of the fiscal policy of
electioneering. Worse, judging by the public opinion polls, event the average
punter out there has been left with a pesky aftertaste from the political
wedding cake produced by the Merrion Street on October 13th.

Tasteful or not, the public gloating about
headline growth figures and the fiscal chest-thumping that accompanied the
Budget 2016 did not stretch far from reality. Official growth is roaring,
public finance are in rude health, and the Government is back in business of
handing out candies to kids on every street corner. The air is so filled with
the sunshine of recovery, the talk about the Celtic Tiger Redux is back on the
chatter menu for South Dublin partygoers.

Ireland
by the numbers

Irish Government is now projecting full
year 2015 inflation-adjusted growth to come in at 6.2 percent followed by 4.3
percent in 2016. Less optimistic, the IMF puts 2015-2016 growth forecasts for
the country at 4.9 percent and 3.8 percent, respectively. Still, this ranks
Ireland at the top of the advanced economies growth league, with second place
Iceland set to grow by 4.8 percent and 3.7 percent over 2015 and 2016,
respectively. The only other advanced economy expected to post above 4 percent
growth in 2015 is Luxembourg. Which is a telling bit: of all euro area member
states, the two most exposed to tax optimization schemes are growing the
fastest. Though only one has a Government gushing publicly about that fact. No
medals for guessing which one.

The problem is: the headline official GDP
growth for Ireland means preciously little as far as the real economy is
concerned. The reason for this is the composition of that growth by source and,
specifically, the role of the Multinational Corporations trading from Ireland.
We all know this, but keep harping about the said ‘metric’ as if it mattered.

Based on the figures for the first half of
2015 (the latest available through the official national accounts), Irish economy
grew by EUR6.4 billion or 6.9 percent in terms of real GDP compared to the
first half of 2014. Gross National Product, or GDP accounting for the
officially declared net profits of multinational companies, expanded by a more
modest 6.6 percent over the same period.

Other distortions arising from this
structural anomaly at the heart of Irish economic miracle are the effects of
foreign investment funds and companies on capital side of the National
Accounts. Back in 2014, the European Union reclassified R&D spending as
investment, superficially inflating both GDP and GNP growth figures. Since
then, our investment has been booming, outpacing both jobs creation and
domestic public and private sectors’ demand. In more recent quarters, capital
investment has been outperforming exports growth too. Which begs a question:
what are these investments about if not a tail sign of corporate inversions
past and the forewarning of the changes in the economic output composition in
anticipation of our fabled ‘Knowledge Development Box’?

Beyond this, the legacy of the financial crisis
adds to artificial growth statistics. Irish ‘bad bank’, Nama, and its vulture
funds’ clients are aggressively disposing of real estate loans and other assets
bought at a cost to the taxpayers. Any profits booked by these entities are
counted as new investment here. Once again, GDP and GNP go up even if there is
virtually nothing happening to buildings and sites being flipped by these
investors.

And while we are on the subject of the old
ways, last month Ireland became a domicile of choice for an upcoming merger
between Pfizer and Allergan – two giants of the global pharma world. Despite
numerous claims that Ireland no longer tolerates so-called ‘tax-driven
corporate inversions’ (a practice whereby U.S. multinationals domicile
themselves in Ireland for tax purposes), it appears thatwe are back in the same game. Just as we are
apparently back into the game of revenue shifting (another corporate tax
practice that sets Ireland as a centre for booking global sales revenues
despite no underlying activity taking place here), as exemplified by the
Spanish Grifols announcement earlier in October.

All of these growth sources also benefit
from weaker euro relative to the dollar and sterling, courtesy of the ECB
printing presses.

Looking at the national accounts for
January-June 2015, Gross Fixed Capital Formation accounted for EUR3.8 billion
or almost 60 percent of total GDP growth over the last 12 months, or nearly 3/4
of all growth in GNP.

In simple terms, the real economy in Ireland
has been growing at closer to 3.5 or 4 percent annual rate in 2015 – still
significant, but less impressive than the 6 percent-plus figures suggest.

Kindness
for the Exchequer

Still, the above growth has been kind for
the Irish Government. In the nine months though September 2015, Irish Exchequer
total tax receipts rose strong EUR2.75 billion, or 9.5 percent year-on-year.
Just over 45 percent of this increase was due to unexpectedly high corporate
tax receipts that rose 45.7 percent year-on-year. Vat receipts increased EUR742
million or 8.3 percent year-on-year, while income tax posted a more modest rise
of EUR677 million up 5.7 percent. While both VAT and Income Tax receipts came
in within 1-2 percentage points of the Budgetary targets, Corporation Tax
receipts over-shot the target by a massive EUR1.21 billion or 44.2 percent.

As chart below shows, in the first nine
months of 2015, Corporation Tax receipts have not only outperformed the
previous period trend for 2007-2014 and the historical average for 2000-2014,
but posted a massive jump on the entire post-crisis ‘recovery’ period.Both the levels of tax receipts and the rate
of annual growth appear to be out of line with the underlying economic
performance, even when measured by official GDP growth.

This prompted the by-now-famous letter from
the outgoing Governor of the Central Bank, Professor Patrick Honohan to the Minister
for Finance in which Professor Honohan politely, almost academically, warned
the Government that a large share of the current growth
in the economy is accounted for by the “distorting features” – a euphemism for tax
optimising accounting. Per letter, “Neglecting these measurement issues has led
some commentators to think that the economy is back to pre-crisis performance”.

Professor Honohan’s warning reflects the
breakdown in sources of growth noted earlier, with booming multinationals’
activity outpacing domestic economic expansion. The same is confirmed by the
recent data from labour markets. For example, whilst official unemployment in
Ireland has been declining over the recent years, labour force participation
rates have remained well below pre-crisis averages and are currently stuck at
the crisis period lows. In simple terms,
until very recently, jobs creation in Ireland has been heavily concentrated in
a handful of sectors and professional categories.

Of course, this column has been saying the
same for months now, but for Irish official media, the voice of titled
authority is always worth waiting for.

The Revenue attempted to explain the
Exchequer trends through October, but the effort was half-hearted. Per Revenue,
the UER800 million breakdown of Corporation Tax receipts outperformance
relative to target can be broken into EUR350 million of the “unexpected”
payments; EUR200 million to “early” payments; and EUR200 million to ‘delayed’
repayments. Which prompted a conclusion that the surge in tax receipts was
“sustainable”.

Turning back to
fiscal management side of accounts, Irish debt servicing costs at end of 3Q
2015 fell EUR296 million or 5.9 percent compared to January-September 2014. The
key driver of this improvement was refinancing of the IMF loans via market
borrowings and, of course, the ECB-driven decline in bond yields. Neither are
linked to anything the Government did.

Spurred by improving revenue side, however,
the Government did open up its purse. Spending on current goods and services
(excluding capital investment and interest on debt) has managed to account for
just under one tenth of the overall official economic growth in the first half
of 2015. In other words, even before the Budget 2016 was penned and the print
of improved revenues was visible on the horizon, Irish austerity has turned into
business-as-usual.

Talking up the future

As the result of the tangible – albeit more
modest than official GDP figures suggest – economic recovery, Budget 2016
unveiled this month marked a large scale U-turn on years of spending cuts and
tax hikes.Even though the Government
deficit is still running at 2.1 percent of GDP and is forecast to be 1.2
percent of GDP in 2016, the Government has approved a package of tax cuts and current
spending increases worth at least EUR3 billion next year. The old formula of
‘If I have it I spend it’ is now replaced by the formula of ‘If I can borrow it
I spend it’.

Which means that in 2016, Ireland will run
pro-cyclical fiscal policy for the second year in a row, breaking a short
period of more sustainable approach to
fiscal management. Another point of concern is the fact that this time around,
just as in 2004-2007, expansionary budgeting is coming on foot of what appears
to be one-off or short-term boost to Exchequer revenues. Finally, looking at
the composition of Irish Government spending plans, both capital and current
spending sides of the Budget and the multi-annual public investment framework
include steep increases in spending allocations of questionable quality,
including projects that potentially constitute political white elephants and
electioneering.

In short, the Celtic Tiger is coming back.
Both – the better side of it and the worst.

Disclaimer

This blog represents my personal views and is not reflective of the views or opinions held by any company, contractor, client or employer I work for currently or have worked for in the past. These views are not an endorsement to take any action in the markets or of any political position, figures or parties.

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